Six Big Mistakes Inflationists Make

Gold advocates and free-market economists have been mainly on the wrong side of inflation for the past 35 years. Since that time, the US economy has yet to experience the stagflation, let alone hyperinflation, that has been expected to happen. To be sure, we have seen steady inflation but nowhere close to the high rates that has been forecasted. The policies of the US Fed has indeed been reckless, but that recklessness has yet to translate into monetary ruin. I’ve been pondering this for a little while and came up with six errors that inflationists make:

  1. Believing that the Fed prints money
  2. Believing that the Fed controls interest rates
  3. Believing that the Fed can stop deflation
  4. Thinking that the situation in the US is similar to Zimbabwe
  5. Believing rising gold prices are indicative of inflation
  6. Believing a falling dollar is indicate of inflation

Mistake #1 – Believing that the Fed prints money

 photo m1m2_zpsx67adgv4.png

According to, M1 was $3.1 trillion as of March 30, 2016. M1 is the total amount of physical currencies plus checking deposits. M1 has indeed spiked from 2009 onwards. M2, which is M1 plus savings deposits and money market funds was $12.6 trillion. M3 which is M2 plus large time deposits and institutional money market funds was about $17 trillion. As you see, despite the recent QE’s, the Fed’s “money printing” is still fairly small compared to those other large amounts. However, when you include the tens of trillion$ in mortgage debt, student loan debt and social security and Medicare obligations, the Fed’s money printing is a drop in the bucket compared to the other sheer amounts. The vast majority of money creation is outside of central banking.

Mistake #2 – Believing that the Fed controls interest rates

An Elliott wave practitioner monitoring the T-bill rate can predict with fair accuracy what the Fed will do. No one monitoring the Fed’s decisions can predict what T-bill rates will do.” (Prechter, 2014)

People overestimate the powers of the Fed. The Fed has direct control over one rate and that is the Fed funds rate, which is the overnight rate charged between banks to maintain minimum reserve requirements (Zaidi, 2015). In actuality, bond investors are in the driver’s seat when it comes to setting interest rates. Whether the demand for bonds is artificially high and whether that artificially high demand is caused by  manipulation is outside of this discussion.

The chart below, published by Elliott Wave International, shows the relationship between the Fed Funds rate and the three-month US Treasury yields. You will notice that the Treasury Bill rates turn first and the Fed Funds rate follows, not the other way around.

 photo fedfunds_zpsz0ncitsf.png

If the Fed was really in command then why were they powerless during the early 1980s when the rates were as high as 15 percent? Obviously they wanted to lower the rates, but couldn’t. It’s not because they wanted the high rates, but because that’s what investors demanded. The Fed is at the mercy of investors. Today, treasury investors accept a very low rate and the Fed is only too happy to comply. The Fed is a trend follower, not a trend maker.

Mistake #3 – Believing that the Fed can stop deflation

The fact that we have not suffered sustained deflation since the Great Depression makes people confident we’ll never see one. They overestimate the omnipotence of the Federal Reserve and it’s ability to avert deflation. Aggressive monetary policy and multiple quantitative easings have all but convinced investors that inflation is permanent.

The Fed’s primary role is not money printing. Their primary role is the facilitation of credit. The world is not so much awash in money as it is awash in debt. Much of the debt generation is through the banking system in the form of loan issuance through fractional reserve lending, not actual money printing. The Fed indeed has helped foster the largest credit expansion the world has seen. It has also fostered the largest debt bubble the world has ever seen. The Fed’s solutions in “fighting deflation” comprises in doing more of the same, which are not solutions at all but merely delay the day of reckoning.

There is a limit to this credit/debt growth. What inflationists don’t take into account are actual human behavior. During economic booms, lenders and borrowers get swept up in euphoria. They become overconfident and make increasingly risky loans. Borrowers in turn become increasingly confident in their ability to take on larger loans. They sees their homes, stock prices, and salaries go up and think they will have no problem paying back their loans. But there is a point where people can’t take on any more debt and when servicing of debt becomes so burdensome as to make paying day to day expense difficult and/or impossible. At that point the boom is over and reality sets in. Bankers begin to find out they made too many bad loans. They become nervous and fearful and even become hesitant in loaning to pristine borrowers. This is psychology in reverse. Under a highly leveraged system, things can unravel in a hurry.

The Fed may do all it wants to try to prevent deflation, but they can’t control the masses of borrowers who experience a psychological shift from that of a desire to spend to a desire to save. You can’t force people to spend or take on loans if they do not want to.

“Can fiscal and monetary policy acting at their optimum eliminate the business cycle, as some of the more optimistic followers of J.M. Keynes seemed to believe several decades ago?

The answer, in my judgment, is no, because there is no tool to change human nature. Too often people are prone to recurring bouts of optimism and pessimism that manifest themselves from time to time in the buildup or cessation of speculative excesses. As I have noted in recent years, our only realistic response to a speculative bubble is to lean against the economic pressures that may accompany a rise in asset prices, bubble or not, and address forcefully the consequences of a sharp deflation of asset prices should they occur.” (Greenspan, 2001) Chairman Greenspan presented identical testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, on July 24, 2001

Mistake #4 – Thinking the US situation is similar to Zimbabwe

In wake of the deadly Second Congo War, sanctions were slapped on Zimbabwe in 2001 in an attempt to oust their corrupt leader, Robert Mugabe, out of office. Because of the sanctions, Zimbabwe could not borrow money in order to pay back the billions they owed to the International Monetary Fund and other institutions. The government decided to literally print money in an attempt to settle their obligations. Hyperinflation resulted.

The reason for Zimbabwe’s hyperinflation of a few years ago was caused by their loss of access to credit which forced their hand. This loss of credit was due to sanctions the West slapped on in an attempt to oust their corrupt leader, Robert Mugabe, out of office. The Zimbabwe government, unable to borrow money, resorted to printing of banknotes.

The current situation in the US is diametrically the opposite of Zimbabwe. As discussed above, the Fed is not in the business of printing money. The Fed’s primary job is the facilitation of credit. The US government’s credit market is the world’s biggest and most liquid. Their debt is among the world’s most trusted, as can be seen by foreigner’s veracious appetite for Treasuries and the near record high prices they’ve been fetching. As of April 2016 the yield on the 10 year Treasury Note is a paltry 1.8 percent, hardly a situation resembling out of control inflation.

Mistake #5 – Believing rising gold prices are indicative of inflation

Throughout the 1970s gold prices rose sharply, right along with inflation. However the 1980s saw gold prices plummeting throughout the decade despite the presence of inflation. In fact the rate of inflation during the 80s was higher than the 2000s yet gold prices rocketed during that latter period.  Rising gold prices certainly isn’t any more suggestive of inflation than rising equity prices or rising home prices. However rising gold prices over the very long term is indicative of inflation. Gold, like many other assets, is subject to booms and busts.

Mistake #6 – Believing a falling dollar is indicate of inflation

Again, like gold prices the dollar index gives you no indication of the presence of inflation or deflation. A rising dollar index does not mean that the actual currency is appreciating. The index measures the dollar’s performance relative to a basket of international currencies. It is usually the case that all currencies are depreciating to some extent, but some are depreciating faster than others. From 1995 to 2001, the dollar index rose from 80 to 120. But as you all know the dollar did not appreciate in value 50 percent. The dollar in 2001 bought you less home and less car than it did six years before.

What I find surprising is that even many prominent followers of the Austrian school make these types of errors. For a number of years free-market and libertarian economists had been jumping on the inflation bandwagon, but now it appears the sentiment is shifting in light of declining energy and metal prices. Although it appears sentiment is shifting, few if any are conceding their mistaken forecasts.




Prechter, Robert, Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression, John Wiley & Sons, Hoboken NJ, 2009

Zaidi, Deena, 4 Myths About Federal Reserve Interest Rates, The Street, Sept 24, 2015.

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